Posts tagged ‘Fiat money’

Many people tend to blame commodities markets for the rising food prices but they fail to recognise that high leverage based commodity market is just a resultant contributing factor and not the root cause. Infact, by selectively putting a bar or “max retail price” on food prices alone or artificially manipulating the rules of the game by selective intervention in the commodity markets, while ignoring the inflation in other sectors e.g., services sector (in form of salaries), will only discourage food production. This is because farmers will always get less money forcing them to quit their current occupation and move to better paying avenues. Why not, for example, ever increasing pay packets of the service class is considered to put under check? If we play by fair rules then while every one has a right to choose the price for the product of his labour, then why a farmer has to work under controled price regime? Why not a bar on the fat-salaries of CEOs, politicians, Film Stars, crickters, Journalists, bureaucrates etc? If the prices of commodities goes up, it is the producer of commodity who gets benefitted (though a major share is still looted by the middlemen). How can a farmer from the rural area pay for rising education or medical expenses or rising prices of industrial commodities without getting a raise in their earnings too?

This ever increasing pay packets for unproductive people which is a result of massive money printing or stimulus economics, is causing prices to rise. There are two types of workers in an economy. Producers and service sector. Producers produce for themselves and for the service sector. In return service sector exist to service the producers. If producers are not satisfied and do not see a value in the service, in an ideal world such jobs should cease to exist and people from service sector should return to production. But that is not happening. Instead it is the service sector that is playing the shots and getting benefitted from the currency devaluation while the producer’s are loosing. Phony and unproductive service sector jobs are being created with huge salaries that a hard working honest farmer can not even dream off.

Further to that a farmer, as all savers in the economy, suffers from the theft of purchasing power. Infact it is this theft of purchasing power that enables sustainence of this huge unproductive service sector. This day light theft by inflation is invisible and therefore simple common man can’t see it. Let us try to understand it with an example. After a full day of toiling in the field, a farmer gets Rs 100 note which he tries to save in the bank. At the same time govt creates many more such notes without enough production in the economy. This devalues or dilutes the purchasing power stored in Rs 100 note owned by the farmer and the same purchasing power is now shared by new money that has come into the economy. Due to this currency devaluation, money is loosing one of its key function “store of value” (Functions of money: Unit of account, Measure of value, Medium of exchange, Store of value). PRODUCTIVE CLASS HAS TO COMPETE WITH UNPRODUCTIVE CLASS FOR THE SAME AMOUNT OF SUPPLIES. THIS CREATES INFLATION.

It is the Fiat money system that is the root cause of price rise where in, it is believed that causing inflation by raising the salary of people results in high production because the pain of price rise will force people to produce more. This however completely ignores that production is a function of hard work and natural resources are constrained. So while it is always easy and cheap to print money exponentially, it is not the same for production.

Price rise is often blamed on hoarders, speculators, weather etc. But Hoarding happens when you know prices are going to rise. Why would somebody do hoarding when prices are falling? And why prices will fall when there is “too much money (which is also increasing) available to chase too few goods”? Prices will fall WHEN THERE IS MORE PRODUCTION. But why would somebody choose the hard work of production when money can be gained through easy routes i.e., by phony service sector jobs sustained by loose monetary policy. In Oct 2008, when TARP stimulus (which is massive money printing to prevent bank default) was first rejected by US congress, all prices including that of Gold fell down and markets crashed. Why no one was interested in hoarding then? Because the bubble was busted and all the money percieved to exist in the economy was gone. Money creates demand; and in the absence of demand, prices fell down. Commodity traders makes money by betting on inflation. They know that more money is coming to the economy which will increase demand and prices will go up. So by hoarding they will win and make money. An example is the recent spike in Gold and Silver prices when Federal Reserve Chairman Ben Bernanke announced that a QE3 (3rd round of massive and unprecedented money printing since 2008 crisis to avoid a financial collapse) is being contemplated. The moment this news came, prices shot up across the countries.We can’t say that hoarders are acting suddenly in an organised fashion across the world in all economies. Prices are rising as a result of central banks’ money printing.

Inflation is the increase of money supply and price rise is its impact. As people become aware of the fraud that inflation is the creation of none other than govts, more and more people will buy commodities as a hedge against inflation. I love this line from Peter Schiff, “It is not prices of commodity going up but the value of currency going down”. Root cause of price rise and resultant social evils, including the casino economy, is Fiat money system.

In 1971 when Richard Nixon brought down the brettonwoods system and decoupled dollar with gold, he used the same excuse “threat of speculators”. An excuse was made to hide the fact that US had defaulted since it has printed massive money and was not having Gold to back it. In the bretten woods conference 1946, US has pursuaded the world that it will only print money according to the gold it has and other countries will peg their currency to dollar. US dollar was accepted as a reserve currency or internationally accepted medium of exchange. So a fixed exchange rate was decided and it was the order until 1971. Now since US was spending recklessley to meet the expenditures from its space mission, korean, vietnemese wars, cold war etc. It started printing massively than the gold it had. This started creating inflation in countries that were exporting to US because they had to print currencies in line with falling dollar to maintain the exchange rate as promised in the Brettonwoods system. This resulted in countries like France getting suspicious and they in 1970 started reducing dollar reserves for gold thereby threatning US economy because it was not having enough gold to pay back. Result was “Nixon shock” when on 15th Aug 1971 Richard Nixon unilaterally announced cessation of direct convertability of dollar to gold thereby breaking the promise it had done to world. The reason cited was “threat from speculators”. Since 1971 we are living in a world with Fiat money system. Fiat money is that money which is not backed by anything and it just need the consent of government to print money as much as they like.

Result of this reckless money printing was runaway inflation in the decade of 70. Later what came to the rescue of US economy were lenders of America, primarily Japan and later China. Goods worth trillions of dollars were loaned to America in the last few decades which temporarily solved the supply side problem while money printing continues to grow at exponential rate thereby creating an impression of growth. GDP growth is measured in terms of growing money while discounting inflation but does not take into consideration the debt which helps to control the inflation. Growth was basically the exponential growth of paper money while inflation was temporarily checked in by raising debt levels.

It was important to discuss United States, because it was US that created this system of Fiat money and the world leadership including that of India emulated it because it saw United States flourishing, prospering, though little did they realise that debt financed prosperity is always at the cost of future pains.

The situation today, however is different. The payback time started in 2008. Exponentially growing Debt requirement has gone up so high that its lenders can not afford it. Lenders like China are supplying goods to America in return for cheaply printed paper that is not backed by anything, most of which they are investing again in buying US treasuries (govt debt). As a result, while the trade surplus of China is growing, inflation is sky rocketing due to shortage of goods as goods that could have otherwise been available for local consumption are being exported.

India is different case since it has been following same path as the US did. While the money supply has been growing exponentially, it is the trade deficit which is increasing unlike the trade surplus of China. This clearly shows that we are importing to meet our growing demands (money). And this import is consumption which is financned by debt. India’s external debt is almost similar to foreign exchange reserve.

In context to India, while the money printing is growing at exponential rate of 15% to 22%, debt levels are rising almost at the same rate. Please see the chart showing GDP, M3 (Broad money supply) and National debt and notice how they all are growing together. More availability of goods helps in controlling prices but if goods are financed by debt then this period of prosperity is only temporary as debt has to be repaid with interest. So more debt is taken to pay for the previous debt and this creates a debt trap. When debt becomes difficult and cost of borrowing (interest rates) increases, govt is forced to control imports. Imports can be controlled by raising the prices of imported commodities (such as crude oil), which is what currently happening in the economy. (Note: Please notice in the chart that how in 2008, M3 crossed over national debt, thus marking a period where debt is becoming difficult and M3 has to be increased to meet fiscal deficit targets.)

Another problem that India has is that a major share of our exports comes from service sector such as IT. We are exporting to countries like US and Euro zone where the trade deficits are enormously high and who are struggling to prevent a default by a series of Quantitative easing or stimulus or in other words money printing. When our customers will go bankrupt, our service sector will be in deep trouble, thereby widening the gap between our income (exports) and expenditutre (imports). Even today our trade deficit is a matter of concern but with financial crisis deepening in west, the situation will be even worse.

The times ahead are extraordinary. From east to west (Japan to US), a threat of debt crisis is looming large. Growth of debt is becoming impossible as the lenders are suffering from their own problems e.g., earthquake in already debt ridden Japan and massive runaway inflation in China. In the absence of debt, supplies are becoming difficult. But money printing (QE1 -Oct & Mar2008, QE2-Nov2010, QE3-an inevitable reality) has to be continued to sustain the unproductive service sector jobs. If the QE (quantiative easing or money printing) is not done then to prevent the default and to run the govt massive austerity is required. This means massive cut in service sector jobs, resulting in a series of defaults, causing a domino effect and bringing the liquidity crisis of 2008 back to life. But if the QE is done, it will further create inflation or price rise, eventually, some day, leading to hyperinflation as happened in Zimbabwe, Yugoslavia, Weimar republic etc. It was the debt that was supressing inflation and creating a mirage of growth but as debt becomes difficult, inflation will explode with an accelerating frequency.

RBI is continuing to raise interest rates but at the same time pumping money into the system to prevent default by government (to bridge the fiscal deficits). While raising the interest rates sucks the money from the system thereby reducing demand, increasing money supply does just the opposite i.e., helps in creating demand. Therefore there is high probability that there will be no respite from inflation because no government will have the guts to embrace a bust and prices will continue to rise until money dies or currency collapses. But even if a bust is embraced it will mean total revolution and as Gerald Celente says “when people loose everything and they have nothing left to loose, they loose it”. The double dip recession or a depression, however is inevitable either by way of hyperinflation (currency collapse) or a liquidity crisis